What a Fed rate hike could mean to mortgage borrowers

Washington Post

Published 1:13 pm, Monday, December 14, 2015

This week’s expected rate increase by the Federal Reserve should not cause home buyers to panic, if history is any indication.

Back in the early 2000s, after the tech bubble burst, the Fed dropped its benchmark rate to 1 percent. Then in the summer of 2004, it began raising it by a quarter percent. At the time of the central bank’s first increase, the interest rate on a 30-year fixed-rate mortgage was around 6.3 percent. During the next four months, it dropped to 5.7 percent.

As the Fed continued to raise the benchmark rate, the rate on a 30-year fixed-rate mortgage declined, falling to 5.58 percent in June 2005. By the time of its last increase in the summer 2006, the rate on a 30-year fixed-rate mortgage was at 6.68 percent. It had gone up less than a half percent even though the benchmark rate had climbed from 1.25 percent to 5.25 percent.

Could mortgage rates follow the same course this time around? Possibly. But keep in mind the Fed hasn’t raised its benchmark rate in nearly a decade. It’s hard to predict how the market will react to such a momentous change.

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“You’ve got 33-year-old bond traders who’ve never in their career seen” the Fed raise its benchmark rate, said Bob Walters, chief economist at Quicken Loans, the largest non-bank mortgage originator.

John Wake, a self-described “geek in chief” at Real Estate Decoded and a real estate agent in Arizona, believes that in 2004 when the Fed increased the benchmark rate it caused an already frenzied housing market to become more manic. Home buyers, worried that rising rates would prevent them for affording a house, became desperate to buy right away.

“The real estate economy is more sensitive to interest rates than most of the economy,” Wake said. “An interest rate low enough to move the needle on the national economy may cause the real estate economy to overheat. We may have seen a bit of that the last couple of years. And because real estate is more sensitive to interest rates, expectations of higher rates have a bigger impact on real estate than most of the economy.”

Wake points out that often what people expect determines what they do. If home buyers expect mortgage rates to increase, they will act as if rates are increasing even if they don’t.

“That could get people to buy sooner rather than later, which could drive prices up even more next year, which is what I am worried about,” he said.

Walters doubts a slight mortgage rate increase will have much impact on the housing market.

“I don’t think most people are going to run out and make a life decision for a quarter of a point interest rate,” he said.

“Long-term rates are determined by the marketplace every day, by traders buying and selling bonds,” Walters said. Traders are “thinking about the returns they are going to get over time. Primarily what they are thinking about, especially on longer term bonds, which a 30-year mortgage goes into, they’re thinking about inflation.”

Inflation has been hovering below the Fed’s 2 percent target. The U.S. economy has been doing fairly well lately, despite turmoil in the global economy, its effect on the dollar and low oil prices.

“You’re seeing a complete decimation of commodity prices right now,” Walters said. “That will influence inflation a great deal. It makes pricing power for wages almost impossible. And if you can’t get wage increases, it’s tough to have inflation. If you don’t have inflation, it’s tough to see rates go higher. That’s the world we’ve been in for a decade. That’s not going away anytime soon. We’ve essentially been at zero percent short-term interest rates for seven or eight years. There’s not even a whisper of inflation. That’ll tell you really how challenging it is for price increases to take hold. And as long as that’s the case, long-term interest rates will stay down.”

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